Kraft Food’s stellar results on Monday were enough to make other food processors wish they were Oscar Mayer weiners. The US maker of the famous hot dogs, Oreo cookies and Velveeta cheese said second-quarter profits rose 3.5 per cent due to strong sales and effective hedging of raw materials prices. Kraft said it has been able to push through price increases without driving away too many customers. Relieved investors pushed the share price up about 5 per cent.
But Kraft’s ability to pass along rising costs may turn out to be unusual. On the same day, food processor Tyson Foods, which sells chicken and meat, said quarterly profits had fallen 92 per cent year-on-year because it had been unable to pass along all of its higher feed costs. Tyson’s share price tumbled about 7 per cent after it said grain costs for the full fiscal year will be $550m higher than in 2007.
Other companies are also likely to be in for a margin squeeze, if history is any guide. Despite recent input price increases, the ratio of US corporate after-tax profits to gross domestic product remains near a 40-year high, according to Lehman Brothers. Slowing economic growth and continued high commodity prices mean that ratio is unsustainable. Merrill Lynch predicts 2009 operating margins will decline from 2008 levels across virtually all sectors, even energy and materials.
Public companies are not alone in feeling the pain. Many recent buy-out targets are facing similar pressures and they have the additional burden of being weighed down with debt. So far, loose borrowing rules and exotic debt granted in the pre-credit crunch days have helped keep corporate default rates low. But rapidly falling operating margins could breach even the lightest of covenants. Even rolled-over obligations must be paid at some point, eroding equity returns. No lender or investor is going to be in love with that.